Monday, 9 February 2009

Independent Directors – Not good enough

Try this one. Ask any independent director of any company, the following 5 questions.

  1. What was the exact turnover and profits of your company for the last quarter ?
  2. What is the annual turnover of your five largest brands/geographies/service lines – whatever ?
  3. Who is the Financial Controller of your company ?
  4. How many employees, to the nearest thousand, does your company have ?
  5. What is your market share in your most important market and what is the share of your most important competitor ?

I am willing to bet that most of them would fail in this test.

This post argues that independence of a director is necessary, but not sufficient, to ensure good corporate governance. A more important criteria is left out, or mistakenly applied – effectiveness.

What sort of people become independent directors these days. Four broad categories of people – chairmen or senior executives of other companies, retired business leaders, academicians and former politicians or bureaucrats. All four, in my opinion are not automatically suited to perform the role of an independent director.

What is the role of an independent director anyway ? My submission is that they are NOT there to contribute to, or drive, the strategy of the company (that’s the job of the full time management of the company). They are there to ensure good corporate governance and to ensure that the rights of all the stakeholders are protected. Period.

The first group – chairmen or senior executives of other companies have no time. Running a company is more than a full time job. They cannot do justice to the intensity of what is required from an independent director. They come for board meetings, certainly contribute to strategy with their vast knowledge and experience, but cannot give the attention and time required for corporate governance.

For retired business leaders, the position is a perquisite rather than a job. Isn’t this what business leaders normally do after retirement ; to be able to say that they serve on the boards of 10 companies. They can devote the time, but usually don’t. They also don’t want confrontation. They would rather have peace and quiet, attend board meetings, make a point or two and go away.

Academicians suffer from a similar problem as serving business leaders. Lack of time. Add to that , all too frequently, incompetence in applying theory to practice. To many, corporate directorships are a big ego trip and a way of ensuring consultancy assignments. They also have not had practical exposure to the running of a business to smell and detect lacunae in governance.

I won’t even comment on the suitability of retired politicians or bureaucrats to do the job.

I’m pretty sure that most independent directors skim through the board papers on their flight to the board meeting. Few have applied their mind to the issues at hand, unless a crisis hits the company. They sit in Board meetings and react to what is presented. No wonder they are ineffective.

What, I believe is needed, are professional independent directors. That should be all they do for a living. Perhaps even organizations in the business of independent directorships. Perhaps even a professional body, a la, CPAs. They would need to spend at least one day in a week with the company. They should travel to company operations. They should build direct lines of communication with key people in the organization. They should have sufficient accounting training to detect frauds or impropriety. They should be able to ensure adequate whistle blowing mechanisms. They should devote their attention fully to governance – not business strategy. They should be paid virtually executive salaries. And, of course, they should be independent. Perhaps then, they will be truly effective .


Prince said...
This comment has been removed by the author.
Prince said...

A comparative study of the published accounts of 50 top corporates on the stated role of their audit committees would lead the shareholder to conclude that oversight on the Board is well controlled. However, I believe that any oversight role in this country is as unacceptable as audit has proved to be. This mindsight will need a "purgatory" before the role can be embedded in the process. Meanwhile, the core checks and balances needed are worth a debate. Who is an independent director when he is voted to office? How can independence be preserved in the process? I dont believe that remuneration is the key; rather, in my experience, it was the advent of managerial ownership that spelt the end of a true and fair presentation? Many of the significant scandals we see today have one or the other of following two characteristics. A promoter owner who finally goes public for the money for good reason and has not reconciled to even marginally be accountable to the new partners. Consequently, given the low or diverse profile of the new partners, the promoters continue their old ways, except now with a professional multi media presentation of the business for the public at large and the other owners. The new partners are carried away as seen from rising PE multiples, which defy financial gravity. And then there is a downturn/ a burst bubble and you can guess who would have already run down their holdings. The other emerging characteristic of this new malaise is professional management which has an increasing equity stake in the company. Given the importance of "performance" in sustaining earnings (at least till the maturity of options), the quasi owners keep the bad news off the public as long as possible. When it happens, we all hear the large slash at the short end of the pool. It cant happen with a professional management in place but it does with an interested management. A debate on these two issues would facilitate bringing in balances in the syatem. For a start, what oversight needs as Ramesh points out, is competence. This is generally available at a price. More importantly, it requires integrity, which is more scarce in our "benami oriented" system, but still exists. How is integrity to be realistically nurtured in the corporate world? I have a take on this but will defer writing till I have read many more views.

Ramesh said...

Thanks Prince for bringing out the dimesion of managerial ownership as a threat to good governance. Do share your take on integrity - as an expert on corporate governance, your's is a valued view.

Anonymous said...

There should be a legal recognition that the role of independent directors is different from the executive ones.They should also ensure that top leader is always subordinated to the instituion and does not become bigger than the co. he/she serves eg.Madoff or Raju.They should ask /probe diligently to understand patterns of performance.governance need not suffer because of emloyee ownership or promoter stakes as Prince avers.Independent Directors should take these on board.deeyes

Ramesh said...

Wise words, especially coming from somebody who is an illustrious independent director himself. Thanks deeyes !

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